While large numbers of people, (the low-paid , young and the haitual self and unemployed) have never been in a company pension scheme, some 30 million of us in the UK have either a private pension in payment or have the prospect of one.
A pension promise is an IOU from somebody to day to you tomorrow. Some of these promises are pretty simple. It might amount to no more than a percentage of your salary paid to an insurance company , the future value of which will pay you income in retirement this is a defined contribution promise and once the money has been paid, you can be pretty sure that you’ll get your pension- albeit without guarantee of what it will be.
At the other extreme, there are some pretty fancy promises made by companies to their staff to pay a defined benefit from a future point, these are normally a series of promises which include the promise to increase payments in line with some definition of inflation and pay a residual pension to your spouse or even kids if you die before them.
Because no one knows what these defined benefit promises are ultimately going to cost, companies have had to pay into funds increasing amounts so that rather than wing it, they can be sure to meet their obligations.
Most people know that the “liabilities”, the full extent of these promises are much larger than had been expected – mainly because we continually underestimate the rate of increase in life-expectancy. However, most people have attributed the bulk of the underfunding of these defined benefit plans to the underperformance of the investments made by the fund.
But the problem we face in looking forward to our retirement is more complicated than just the short-term deficit. There is a fundamental question that needs to be answered.
Is the employer who promised me this “guaranteed” pension either able or willing to meet the IOU?
Not to be too patronising but most of us pension experts talk about this in smoke-filled rooms and wouldn’t want the majority of members to ask the question let alone to look for an answer.
Until recently there was very little information about the strength of the promise but that is changing. A new industry within the pension industry has sprung up which makes its business to assess what is being called “the employer covenant” and the results of this work are beginning to leak into the public domain.
This week PWC published a report that gives some high level numbers on the capacity of Britain’s top 350 publicly quoted companies to meet their pension debts. It’s good to see and let’s hope that there is sufficient interest in the findings among journalists, politicians and consumerists for us to be able to get some of the detail on individual company’s positions, made available to those who really need to know , the member so the schemes to whom promises have been made.
Here’s what PWC have got to say.
We have recently released our Pension Support Index (“PSI”), which takes a new approach to the UK legacy Defined Benefit pension issue. Until now, most commentary about the risk of Defined Benefit schemes has concentrated on the size of pension scheme deficits. But, while that gives a snapshot of the state of a scheme at a particular point in time, it’s not the critical issue. The important question isn’t the size of the pension deficit – it’s whether a company (the sponsoring employer to the scheme) has the ability to support its obligations.
Since June 2007, we have seen the PSI fall by almost 25%, indicating the level of support provided to schemes by the FTSE 350 has decreased substantially. The outlook does not look good and the recent trend continues to be downward. In the report, we examine what this will mean for companies, trustees, scheme members and other stakeholders.
Please click here to access your copy: http://www.pwc.co.uk/pensionssupportindex
I hope you enjoy the publication – if you would like to discuss any of the issues raised, or provide feedback on the content, then please do get in touch with myself or one of the team contacts.
Time to bite the bullet Pensions Support Index: employer support for Defined Benefit schemes pwc.co.uk
The Pension Support Index tracks the ability of FTSE 350 companies with Defined Benefit pension schemes to meet these collective obligations, new perspective on the UK legacy pension issue.
Of course, even if your promise is broken , you’re unlikely to be totally out of pocket, there is a safety net put in place by levies on the remaining schemes which pays a pension through the Pension Protection Fund but this is only a safety net, not a fully comprehensive insurance policy paying “like for like”.
So this information is still of great importance.
Well done PWC – let’s hope this is the start not the highpoint of disclosures on this important issue
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Longevity improvements wouldn’t have been too much of a worry if interest rates had remained high – and they may still go up higher than generally expected at some point to counter high inflation caused by stored up QE (effectively printed money to lubricate the system). Higher interest rates generate more than enough income and longevity improvement becomes a secondary issue.
Inflation guarantees would not have bitten so deep between 1991 and 2011 (100% of cumulative RPI has been matched for most whether preserved or in payment). Weaker inflation guarantees would have acted as a safety valve for sponsors of final salary pension schemes, but continuous sub 5% inflation effectively fully index linked pensions, when originally the legislation was aimed at assisting promised pensions to keep in touch with high inflation – not fully index link them.
The unintended consequence from well intentioned legislation and Government changes in economic policy have exacerbated the plight of sponsors of final salary/career average pension schemes. Goal posts were moved with insufficient analysis of the potential outcomes.
Mortgage payers and other borrowers are reaping the benefit of low interest rates. Any serious prolonged increase in interest rates would almost certainly harm the fragile housing market. The residential property market became inflated due in part to easy credit and low mortgage rates, so any reversion to higher interest rates would be political suicide, as 1993/4 style repossessions and falling prices would not be forgiven by the electorate.
Sponsors with debt and pension scheme deficits must look holistically at the impact of higher interest rates. Would a lower deficit and recovery payments be offset by higher interest costs for corporate debt?
One hopes that companies and consumers are paying down debt whilst they can, or using the present lower interest cost to fill holes in deficits, with consumers also hopefully saving more in pensions. Those that don’t had better have robust business models that throw off cash, or secure jobs with good pension schemes! Any vacancies at the Bank of England?
Great comment Stephen. Of course to pay down debt, companies need to be strong. the alternative, gratuitous largess to executives and stellar rewards for shareholders are the issues that trustees should be most concerned about.
I wouldn’t mind Stephen Tiley in the BOE, but I suspect that few bankers would!
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